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Different Strokes For Different Exchanges

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One of the thing that really bugs me about exchanges is that there is no real standardization.  Unless you hear from a friend or actually open an account, it’s hard to know how it really works.

Coming from the CFTC side of the business, there was a certain amount of standardization.  No payment for order flow.  No wash trading.  When you saw volume and open interest in a contract you could be relatively sure what the liquidity pool would look like. When you are trading, you have to be able to get in, and get out of a position.  Less liquidity and the price to play goes up.  The SEC side of the business is a lot murkier.

Stablecoins are the rage, but the way to hedge risk in crypto is via traditional means.  If you used futures, options and OTC bilateral derivatives, you would be able to hedge with more liquid markets being created in cash/futures.  It worked for the Japanese in rice futures back in the 17th century and it worked for farmers hedging grain at the CBOT in 1854.  What we need is a big futures market, not stablecoins.

This came from The Ledger, a Fortune Mag crypto mailer you can sign up for.

PwC is backing a cryptocurrency—specifically, a so-called stablecoin backed by the U.S. dollar.

The accounting firm is partnering with Cred, a decentralized lending startup that’s developing a new stablecoin pegged to the dollar, PwC announced Monday. PwC will offer its accounting expertise to ensure Cred’s dollar-backed coin “can provide 100% transparency and value substantiation,” the firm said in a statement.

To hear PwC tell it, a lack of trust in stablecoins—and the existence of the dollar reserves backing them—has been keeping many potential investors out of cryptocurrency entirely. According to PwC, making the dollar reserves backing stablecoins fully auditable will “usher in the next 100 million users of crypto assets.”

The problem is who really knows what the dollar reserves are?  I don’t have the confidence that PwC can audit them accurately.  Futures allow users to hedge risk with speculators who grease the wheels of the marketplace.  For example, in grains farmers hedge their risk of sales and producers like General Mills can hedge their risk of purchase.  This isn’t rocket science and it is stupid to overcomplicate things.

A private group of my acquaintances and I follow the crypto exchange world pretty closely.  We don’t know everything about everything but there are some smart cookies in our group. One of them predicted the demise of Tether a few weeks ago and yesterday it happened.

In a newsletter that you can subscribe to called Mining Bytes they had this to say on 10/5.

Tether is part of a class of cryptocurrencies known as stablecoins: tokens which are pegged to some other financial value. In Tether’s case, it is pegged to the US Dollar by the fact that, ostensibly, every Tether in existence supposedly is backed by a corresponding US Dollar held in trust. However, serious doubts have been voiced in the past about whether this claim is in fact true 1,2. Occasionally, divergences of over 5-10% have been witnessed in trading between the USD-Tether exchange pair.

Liquidity in listed USD-Tether pairs is very thin, so in order to get a better picture of the true price of Tether relative to USD, we created an index known as the Tether Indicative Price (TIP), which tracks the true price of Tether in USD across multiple different exchanges, some of which use Tether and others which use USD. The price of crypto outrights is compared to derive the TIP. 

To prove that Crypto isn’t some new fangled asset class that defies classical econonmics, I lifted this from the same article.

An interesting parallel may be forming between today’s crypto market and an episode of financial distress was known as the Kipper-und Wipperzeit that occurred almost 400 years ago around 1600 in what is now Germany. I will quote a passage by Kindleberger:


This pathological financial episode is interesting in its own right as financial crisis is demonstrated to be possible with only metallic money and without bank credit. Princes, abbots, bishops, even the Holy Roman Emperor debased the subsidiary coinage used in daily transactions (but not gold and silver coin of large denominations)…
Debasement was limited at first to one’s own territory. It was then found that one could do better by taking bad coins across the border of neighboring principalities and exchanging them for good with ignorant common people, bringing back the good coins and debasing them again

Kindleberger informs us that the ultimate outcome was that “[debasement] accelerated in hyper-fashion until a halt was called after the subsidiary coins became practically worthless, and children played with them in the street.”

It’s really easy to match trades. The hard part is the rest of running an “exchange”. Dark pools tend to dry up when volatility hits. So do small markets. Participants might have an illusion of liquidity when things are good. But, unless there are strict rules on how liquidity is provided, it’s merely an illusion.

Economics is often called the dismal science.  I suppose some of that is because it can be unyielding when it comes to concepts.  They don’t change over time and they are often hard to quantify.

Crypto thinks it can bend a lot of existing economic theory.  Seeing Tether become unhinged yesterday reminded me of Professor John Cochrane’s article in April on Basecoin.

What it looks like to me is the smart money is long gone from Tether and the bag holders are left holding the bag.


Source: http://pointsandfigures.com/2018/10/16/different-strokes-for-different-exchanges/


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